While industry’s investment losses are beginning to show, the strong performance from recent years makes institutional investors reluctant to change their investment course. “Not an easy situation,” says the chief of Europe’s biggest pension body. Institutional investors, in Luxembourg and elsewhere, are facing the current complex economic and political situation with concern, not with fear and trepidation.
The panel discussion among insurance and pension sector representatives at last week’s Alfi’s Global Distribution conference made clear that, at a time when real estate investments face pressure from rising borrowing costs, institutions have yet to make major adjustments in their portfolios, such as increasing their exposure to private markets or fixed income.
So far this year, the industry has lost a “relatively small” amount of 184 billion euro, out of its trillions in assets, said Matti Leppälä, secretary general at PensionsEurope, Europe’s leading funded pensions association that brings together 24 European national associations covering pensions of more than 110 million Europeans and more than seven trillion euros in assets, in a discussion led by PwC partner Steven Libby.
Comfortably-high funding ratios
Leppälä presented recently-published European Central Bank statistics showing increased funding ratios for pension funds. This ratio reflects their current financial position, expressing the ratio between available assets and liabilities. “At the moment, end of second quarter this year, Euro area pension funds had the highest on-record funding ratios at 127 percent”, in part due to great results from 2021.
“Is that the reality of pension funds? Not necessarily. You’re losing money, but it looks like everything is fine,” Leppälä said. “So huge challenges in what to do and how to communicate these issues to people, members or beneficiaries, who increasingly bear the risks of their own pensions. So not an easy situation.”
Stable portfolios
Lombard International Assurance S.A.’s chief investment officer Europe, Andreas Meier, said that his company has yet to make big changes. “I would say that strategic asset allocations of the typical five or six different portfolios has not really changed. Not yet.”
Meier presented historical data showing there’s no clear relationship between inflation and stock market performance and pointed out that the S&P 500 has had only five years of negative absolute performance in the past 22 years.
Increased private equity
In terms of asset allocation, Leppälä said his industry has seen “a lot of sales in private equity, with good profits.” But he said “not any drastic changes in asset allocation.”
Meier said that Lombard has about 15-16 percent penetration in total in private markets in its policies. “The reason probably is the investment horizon of life insurance policies, when you use them as an investment vehicle, is more than 10 years, which gives you the long breadth and the patience you need for these types of asset classes.” He emphasised that this level has been reached in the past three years “not as a reaction to the recent crisis.”
He said there had been a shift in where private asset investments flow to, from the predominant area in the past three years being real estate. “This has changed since a couple of months. Guess where the new target is for private market funds: It’s private debt.”
Tempered enthusiasm
Leppälä explained that pension funds have been using private market investments quite a bit in recent years because of the low interest rate environment. “Alternatives like real estate, I think they traditionally have been very good for pension funds,” he said. “They’re good also as hedges for inflation, as infrastructure as well.” He tempered his comments by pointing to challenges in this market, with some assets becoming highly valued in many parts of Europe. “We see some shifts already, like in the Stockholm region, I think the prices are dropping.”
Meier pointed out that he’s seeing asset managers making tactical changes, for example larger players are underweight European equities by two to three percent. He explained that the missing investment is typically redeployed to 10-year fixed income instruments, which he described as “remarkable”, as “we’ve only started yield hikes and the shift of the curve.”
Getting ESG rules right
On sustainable investing, both panellists see a problem with the design of the legislation. Meier of Lombard said he’d read ESG regulation a dozen or more times. “I understand why many people still don’t get it,” he said. “How can you draft regulation like this for such an important topic, where you want to change the world?”
Leppälä chimed in, saying that ESG is important for risk management. “We need a regulatory framework and supervisors who support this, but don’t make it overly complicated and counterproductive,” he said. “It is really baffling how some of this European regulation actually plays out and how complex it is.”
Everyone wants better regulation, he noted, adding, “but in sustainable finance, it is as important as any other financial market regulatory issue and this issue I think has been moving faster and stronger than at least what I remember anything before on every level.”